Own the Market

REVIEW SUMMARY
Company. Cooperative Services of Florida and LeeSar
Industry. Health care
Key. Medical manufacturers lust after market share and give preference to those who can deliver.

One of Robert Simpson's management secrets is giving his employees time to think.

The CEO of a medical supply-buying cooperative in Lehigh Acres is so adamant about it that he's asked architects to incorporate a “thinking room” inside a vast new distribution facility that's being built in Fort Myers.

“Do you know how many businesses would do better if they just gave employees time to think?” Simpson says.

The “thinking room” will have soft music and plush furniture. Every wall in the windowless room will be a giant whiteboard so a handful of employees at a time can sketch out their ideas with markers. Only Simpson will have the keys to the room, so it won't be a refuge for bag lunches or a quick snooze.

Thinking about new ways of delivering medical supplies has paid off for Lee Memorial Health System and Sarasota Memorial Health Care System. In 1998, the two hospital systems partnered in a rare venture to form their own purchasing alliance to gain the upper hand on the skyrocketing costs of medical supplies.

Together, they formed two nonprofit companies: Cooperative Services of Florida and LeeSar. Cooperative Services acts as a group purchasing organization and negotiates contracts with medical-supply manufacturers, distributing its profits to hospital members after expenses. Last fiscal year, for example, Cooperative Services returned nearly $9.4 million to its members, an increase of 19% over the prior year.

Sister nonprofit company LeeSar manages, purchases and distributes the medical supplies for which Cooperative Services has contracted. It sells those discounted items to its hospital members and other health care groups such as hospice facilities and ambulance services. Sales in fiscal 2010 rose to nearly $142 million, a 26% increase from 2009, and net income surged 285% to $4.4 million.

In return for deep discounts, Cooperative Services promises manufacturers that the hospitals will use their products more than 90% of the time. That shows up in the hospitals' financial statements in recent years as steady declines in supply expense as a percentage of operating revenues even though patient volumes have grown.

The cooperative's success has attracted attention from other hospital groups that want in on the deal. In the past year, Lee Memorial and Sarasota Memorial sold non-controlling interests in Cooperative Services to Central Florida Health Alliance in Leesburg and The Villages and Huntsville Hospital System in Huntsville, Ala.

But the existing members are wary of expanding too fast. After all, they've got a good system. “We cannot justify adding any new partners or services if there's going to be any erosion in the service that we already have,” says Jim Nathan, president and CEO of Lee Memorial.

Market share
What manufacturers of medical supplies and equipment want most is to control market share, says Simpson. So if Cooperative Services and LeeSar can promise more than 90% market share for their product, manufacturers will cut prices and even pay Cooperative Services a patronage fee.

From bedpans to gauze, medication and pacemakers, Simpson promises the hospital members will use only one product in exchange for discounts and patronage fees. “We control the marketplace,” Simpson says.

“It didn't come easy,” says Simpson, 66. But the onetime Teamsters truck driver with a booming voice cuts an imposing figure. “I shut down all the purchasing departments in the hospitals,” he says.

When Simpson was appointed chief executive about nine years ago, the cooperative wasn't meeting its compliance objectives. That's because it was only able to fulfill 62% of the hospital orders. Immediately, Simpson ordered staff meetings every Thursday at 3 p.m. and held everyone to account. Within a month, the operation was fulfilling 99% of hospital orders.

With fulfillment orders meeting demand, it was easier for Simpson to persuade hospital administrators and physicians to comply with the manufacturing contracts. “You'll never see a surprise from me,” he promised them.

Pacemakers in the trunk
Simpson's operation is much more sophisticated than just negotiating better terms on medical equipment. A recent deal with pacemaker manufacturers illustrates the creative thinking.

While pacemaker manufacturers wouldn't want you to know this, their salesmen carry these life-saving devices from one hospital to the next in the trunk of their cars. Inventory gets lost, damaged or it simply expires. “They can't track them, so manufacturers try to sell us more than we need,” says Simpson.

What's more, salesmen facing end-of-quarter quotas often discount their remaining inventory if hospitals buy bulk. For example, they might offer $1 million worth of pacemakers for $700,000.

But when hospitals buy in bulk, it ties up precious capital in inventory that could be used elsewhere. What's more, hospitals have to keep the inventory under lock and key because each pacemaker is a little treasure that costs $40,000 or more.

So about a year ago Simpson and his staff approached the pacemaker manufacturers with a deal. Borrowing $40 million from Fifth Third Bank, Cooperative Services and LeeSar agreed to buy hundreds of pacemakers at deep discounts and take over their storage. Manufacturers passed on the savings from pacemakers that would have been lost in their salesmen's cars, and it freed up hospital capital from being tied to inventory.

LeeSar hired one full-time employee whose sole mission is to watch over and manage the pacemaker inventory that comes directly from manufacturers, now down to a more manageable $12 million to $13 million worth. Manufacturers deliver them “just in time,” so the hospital doesn't have to carry the inventory.

And they don't have salesmen with pacemakers in the trunk of their cars.

More services
Cooperative Services and LeeSar plan to deliver more services to more clients, especially where they interact. Consider a recent deal to supply Lee County's fleet of ambulances, another example of good thinking.

Lee County ambulances used to carry different supplies than the hospital. So when a patient got an intravenous drip line in the ambulance, it got removed at the hospital because nurses there used ones made by a different manufacturer.

Now that LeeSar supplies all the Lee County ambulances, emergency medical technicians use the same supplies as the hospitals they serve. “You do more than cut price,” Simpson explains. “You eliminate waste.”

In addition, LeeSar repackages potentially dangerous anticoagulant drugs like Heparin from tiny bottles with fine print into ready-to-use syringes wrapped in cellophane and marked with big letters to avoid medical errors (more good thinking). It also packages liquid medications into cups containing individual doses so entire bottles don't go to waste on a single patient (still more good thinking).

In a new $27 million facility it is building in Fort Myers, LeeSar plans to build a surgical instrument sterilization facility and a food preparation “cook and chill” kitchen to serve Lee Memorial hospitals. It is also exploring instrument and equipment repair. “There's no end to this,” Simpson says.

But clearly there have to be proven savings before Simpson and his staff of 280 plunges into a new service. “I want payback in the first 12 to 18 months,” he says.

“Our partnership is achieving annual savings of 10%,” says Kim Savage, a spokesperson for Sarasota Memorial Health Care System. “We have saved tens of millions of dollars over the years in reduced operating costs and increased efficiencies.”

Bigger is not better
Cooperative Services and LeeSar's success at driving down costs is somewhat counterintuitive because with 80 customers they aren't nearly the size of some group-purchasing organizations that have hundreds of members.

You would think that the more hospitals you have in your group purchasing organization, the more you can drive down costs. “That theory is incorrect,” Simpson says.

That's because contracts that manufacturers have with many such large organizations can't get individual hospitals to fully comply with the terms. Often, administrators are too weak to enforce 90% or better compliance or rival manufacturers skirt each other by selling directly to physicians.

Simpson's conclusion: “If you get too big, you can't control it.”

But Simpson does acknowledge that there is a sweet spot where volume gets the best price. In Simpson's words: “How much more meat is there on the bone?” He's hired consultants to help him explore where that point might be.

That's in large part why Cooperative Services and LeeSar haven't expanded ownership of the group significantly. In the last year, the Huntsville and central Florida hospital systems joined in the buying cooperative, but Simpson says many more have asked to participate. “Hospital administrators aren't trained in this,” Simpson says.

One possible avenue for future growth is helping other hospital systems establish and develop their own distribution systems based on the LeeSar model. With reimbursements falling and hospitals struggling to pay for indigent care, administrators have to look at ways of staying in business. “We have no choice but to look at ways to be creative,” says Lee Memorial's Nathan.

If that's an indication, the new thinking room will be packed.